I promise you I am not telling anyone anything new here. If you are an investor in the solar-panel industry and have not noticed a supply glut then you are completely non-observant.

What is strange though is that despite the supply glut the capital expenditure in this business - that is building new plant and machinery - goes on regardless.

Here is a line from the balance sheet:

Trina Solar Limited

Unaudited Consolidated Balance Sheets

(US dollars in thousands)

December 31,

September 30,

December 31,

2011

2011

2010

Property, plant and equipment

919,727

783,328

571,467

Property plant and equipment at Trina went from 571 million to 920 million in one year. And in the year when the industry became hopelessly oversupplied.

Moreover the rate of increase accelerated in the fourth quarter when the oversupply was obvious to anyone to see - when anti-dumping cases against loss-making Chinese solar panel makers became vogue.

There are lots of things that might be going on here. The company might have a great new technology which is worth investing in even though the industry is glutted (indeed the company points to its "honey" technology). Or the company might be insane. I have my thoughts but I do not have enough knowledge to be certain.

But one friend suggested that this is just an analogue for all of China. Who cares if office buildings are glutted? Just build more. Who cares that the high-speed-rail between two cities you have never heard of, a railway line that consumed valuable steel and concrete by the millions of tonnes is mostly run at a third capacity with empty trains? Build more.

"Build it and they will come" may be the Chinese mantra. Usually only works in Hollywood films.

John

PS. I should disclose that Bronte still has a short-biased straddle on Trina - but it is a much smaller position. We closed a fair bit for profit - but traded that bit not so well. I should have covered the short end more aggressively when the stock was $6.

21 comments:

Anonymous
said...

You're assuming a market-based economic model. China experts generally believe the gov will prop up the largest 2-3 solar companies no matter what, and force the rest to shut or merge. Therefore, it is essential that they remain among the largest to survive. Also, the Chinese planners claim they're going to grow their internal solar market by orders of magnitude in the next 15 years, so negative gross margins for a few quarters may pay off.

to be fair investing through a downturn for marketshare is a time - honored strategy and theoretically should work if you have the lowest cost of production, which Trina claims (and on an efficiency adjusted basis they are below First Solar by a fair margin with polysilicon at $30 / kg). Add to that what the first poster mentioned that China will bankroll the top producers and allow the marginal to die and that China will invest in downstream subsidy of the solar market and it's not impossible to envision TSL surviving and being thinly profitable in the future. Whether it will ever be a business that generates good returns on capital for shareholders is another story, I doubt it.

The Chinese RTOs were easy pickings because they tended to be small, private, and located in politically nonstrategic sectors. You could short them with reasonable confidence that they would not be propped up.

Not so for companies in strategic sectors. Economic analysis is not enough in these situations.

The straddle is clever, since it removes the political factor from the analysis. As with all straddles, it relies on the options being underpriced relative to the actual probability of a move.

You may want to pick something other than rail to illustrate your point of wastage. Train tickets are still hard to buy esp during the Spring Festival season. High speed rails are generally well occupied even though they still may not make economic sense even at full occupancy. Transportation by rail is still generally hard to procure. Much of the regional coal shortage is rail capacity related not coal production related.If Australians can build bigger homes and account for that as residential investments, in theory there is nothing wrong with Chinese building loss making solar producers that actually produce something that can meet policy goals of more sustainable energy supplies. The problem is that Chinese government policy may not reflect the demand of Chinese populace. The mismatch produces strange bed fellows: on one hand we have the Chinese subsidy mostly flowing outside of China up till now so essentially not benefiting the general Chinese populace; on the other we have the beneficiaries of the subsidy (Western consuming countries) vociferously protesting the benefits they received. This is rather similar to the issue of agricultural subsidy in the developed countries. In theory people in less developed countries could have enjoyed the subsidy and just go on with their lives doing something more profitable. But in reality the inability of their society to adapt led to charges of social destruction by the West. In China's case the roles have flipped.

Rail is a great example of Chinese capex waste. It's senseless to cite the Chinese new year travel, which is a short spike and well above normal demand; if capacity is built according to this short spike, the overcapacity for the rest of the year will be truly horrendous. The regular (non high speed) rail passenger ticket pricing is artificially depressed in order to lower inflation and create shortage. This shortage is crucial for officials to benefit personally as tickets are allocated to scalpers. Freight tariffs are also set low to create shortage, so officials can allocate quotas. There is no difficulty in buying high speed rail tickets whatsoever, because high speed rail is way ahead of demand in china.

This reminds me of the SRAM/DRAM market in the 90s. I traded in/out of Micron and watched with amazement how the memory manufacturers would continue to build new fab facilities in the face of global gluts and industry losses.

I've always been skeptical when US manufacturers make dumping claims against low cost Asian exporters but thought it possible that the South Korean memory manufacturers were willing to suffer losses in the short/medium term to effectively run the competition out of business - Chaebol had huge resources before the late 90s Asian crisis and could cross-subsidize losses for a long time.

The solar case today is obviously different but I can't imagine anyone beating the Chinese on cost. All they have to do is hold out until the competition is run into the ground. Whether this is technically dumping is irrelevant - the competition will be bankrupt by the time the case is settled.

The Chinese motor industry is similar - plants running at 50 - 60% of capacity, but capex to double size typical. While the JV's with foreign brands are minting cash, the Chinese brands are loss making in aggregate. I think that it may be much easier to pad a loan for an expansion project to cover your existing losses than to get specific facilities extended for working capital etc.

"In a market economy, the financial sector plays a resource allocation role, but in a planned economy it merely plays an accounting role" Sir Andrew Crockett (former manager of the BIS at JP Morgan's China Conference)

The wrong questions are being asked. What should be asked is if the current capital spending will be depreciated before increased demand justifies it. For the semiconductor and the solar panel industry this is probably not the case. The rate of depreciation is just too great. The infrastructure capex probably is justified.

Frontloading infrastructure capex makes sense. Railroads, bridges and tunnels will still be there in a hundred years. A high speed train line between Beijing and Shanghai that is time competative with airlines will still be competative in a hundred years time. A slow depreciation rate over time warrants investing in over capacity now.

Applying this criteria to real estate capex raises uncertainties though. The Empire State building, 40 Wall St. and the Chrysler building were all built for over capacity during the Great Depression. But over the years those buildings met with a growth in demand for office space. In China however it seems that real estate is being built with a thirty year life cycle in mind, and it is unclear if demand will catch up with capacity within that time frame.

Ferry has a good point. I always marvel when driving over the Golden Gate and Bay Bridges. I can't possibly imagine them being at capacity in the thirties. And still they are here, meeting modern demand.

Anonymous,I think you are confusing lack of economic profit and non-optimal allocation of resources with total wastage. Without price transparency and open competition you may have waste relative to optimal resource allocation, but that is hardly proof that the whole thing is senseless.

I'm curious about Ferry's "30 year lifespan" comment about Chinese real-estate. I understand the recently built American houses (thin sticks of wood covered by wire mesh and stucco on the outside and drywall on the inside, or mobile homes of even flimsier design) falling apart after an average of 30 years, but I thought the Chinese were building hi-rises made of reinforced concrete. How do you cut corners on a reinforced concrete building so that it lasts only about 30 years, without making it so flimsy it collapses immediately?

A primary goal of the Chinese leadership is to erase the memory of past humiliations at the hands of the West, by "making the rest of the world addicted to cheap manufactured goods, the same way we were once made addicted to opium"--words of a Chinese official in an interview that I read long ago. In all the mercantilists (Japan, Germany, South Korea, Taiwan) industrial policy is motivated by memories of past military defeats and anticipation of future military conflicts. Capital investment is not intended to raise future civilian consumption or living standards, but rather to prepare for war. If capex significantly reduces the possibility of losing a war, then it is typically a good investment, regardless of the discount rate used, since losing a war is an absolute disaster for civilian living standards.

My comments were less intended to "prove" the Chinese rail capex waste (I think so but takes a lot of space) than to simply point out the many errors in your statement about chinese rail demand. Without understanding demand you can barely begin to have a view on capex.

I base the 30 life cycle on common complaints of rushed real estate developments and comments like these:

"In April, Qiu Baoxing, vice-minister of the ministry, said during an industry forum that Chinese buildings can only stand for between 25 and 30 years. In contrast, the average life expectancy of a building in Britain is 132 years and they last around 74 years in the United States."

The reason a buildings needs replacement in thirty years time is usually not that it is about to collapse, but that cheap and rushed construction created a building that is more expensive to maintain than a better constructed new building. Things like sick building syndrome will also play an important reason for the future demolition of the current inventory.

Can somebody explain to me where the money is coming from for the increased capex? Is it really "under the table" funding from the government, or does Trina truly have the cash reserves (and/or bona fide credit lines) to pay for this stuff?

As an investor, it makes me nervous to think that Trina's financial statements could be providing less than the whole truth. I feel like this has been an undercurrent in the accounting of all of the publicly-listed Chinese PV companies, but up to now there has been no proof except for unusual line items like this one in the balance sheet.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.